Five Pillars of Financial Freedom: Home Ownership – Part One

“Owning a home is a keystone of wealth – both financial affluence and emotional security.” – Suze Orman

This is the third installment in our series entitled “Five Pillars for Financial Freedom.” If you missed Part One, check it out here, and if you missed Part Two on bad debt, make sure to check it out. Next, I am going to explain, in this three-part mini-series, why home ownership is a pillar in the foundation of your financially free future. If you own a home, buckle up because you are about to learn why buying a home was a wise decision. If you do not own a home, this article will demonstrate why that should be at or near the top of your financial goals. The big idea is simple – a home is great investment because of its utility, social benefits, and financial benefits. If you analyze it solely from a financial perspective, there are much higher rates of return to be had than those found in real estate.

#1 – Leverage

Leverage is using borrowed money to buy an asset. It is an asset because you expect the profits from it to be greater than the interest you pay on the borrowed money. A simple example is the home mortgage. You borrow money and pay interest on that borrowed money. Currently, on a 30 year fixed loan you might pay 4% per year on the loan.

Why would you ever want to borrow money to buy a home if you have to pay 4% interest per year? Putting aside the social benefits and looking purely from a financial perspective, you would only borrow the money and pay the interest if you expect to be wealthier at the end.

Imagine you buy a $200,000 home. Assume you pay $20,000 when you buy the home, as a down payment. Your balance sheet would show an asset of $200,000. However, you would also have a liability of $309,365.11 ($180,000 (principal) + $129,365.11 (interest over 30 years)). On paper, you are actually $109,365.11 poorer after buying the house! So why do so many advocate buying a home? Because you can buy an asset that is likely to be worth more than $309,365.11 at the end of 30 years plus you will have received a multitude of other benefits.

According to the Case-Shiller Home Price Index, from 1928 to 2013, the rate of return on a home was 3.7%. We should then expect that at the end of 30 years, your $200,000 home will be worth just about $595,000 (1.037^30 * $200,000). Not a bad deal, plus your $400,000 capital gain will be tax-free if you are married (we’ll discuss this later). By making a $20,000 investment, you have forced yourself to save and received the benefit of some appreciation and are left with a $600,000 piece of real estate you could sell.

#2 Utility & Social Benefits

It almost goes without saying but you can put $20,000 into a purchase and you get the value of living in a $200,000 home. You get a roof over your head, and a place to sleep, shower, and study. The use of the home is the primary benefit in my opinion. You can own a dog or plant a garden. There are any number of benefits of owning a home that are primarily based upon your desired use of the home. The skeptic might argue that those benefits can be realized by renting too. This is only partially true because many landlords prohibit renters from certain activities such as owning a dog or cat.

In addition to the utility provided by owning a home, there are significant social benefits. Here is a list of statistics that demonstrate the positive social effects of owning a home versus renting:

The decision to stay in school by teenage students is higher for those raised by home-owning parents compared to those in renter households.

Daughters of homeowners have a much lower incidence of teenage pregnancy.

Changing schools, which renters do more frequently than owners, negatively impacts children’s educational outcomes particularly for minorities and low income families.

Parental homeownership in low-income neighborhoods has a positive impact on high school graduation.

The average child of homeowners is significantly more likely to achieve a higher level of education and, thereby, a higher level of earnings.

The children of homeowners with down payments are generally less likely to drop out of school than those of renters. However, those parents who buy homes without making a down payment have children who behave like children of renters, and thus those children are more likely to drop out than homeowners with down payments.

Now don’t freak out if you are a renter. One of the key questions with any statistic should be whether the independent variable (home ownership or renting) is causing the dependent variable (less teenage pregnancy) or the two are simply related. Another example might hypothetically be that Democrats have higher incomes than Republicans. The independent variable (D or R) is probably not causing higher income, the two are simply related for some other reason. So don’t go become a Democrat just to make more money, and don’t go buy a house to prevent your child from dropping out of school.

What I think is going on with these statistics is that home owners tend to move less frequently than renters. Thus, that lack of movement we could call stability. That stability in turn leads to deeper relationships, greater accountability and oversight, as well as other social benefits that may not surface until many years later (think about the guy who gets a job from a high school buddy or gains a new client because he was friends with the client in high school, that is much less likely for the military kid who never stayed in one place for more than three years).

Come back manana for part dos in this mini-series on the benefits of home ownership!